Norfolk Southern Is Worth $78 Despite Coal Weakness

Norfolk Southern (NYSE:NSC) had a quiet quarter as reflected by its recently published Q2 results. During the quarter the company’s coal freight volumes declined while automotive and intermodal freight increased significantly. Overall revenues slightly increased with the help of improved core pricing and fuel surcharges. The quarter saw a decline in major expenses, resulting in margin expansion. ^[1] The shift from heavy reliance on coal freight was prominent as the company managed to overcome significant volume loses in coal freight through growth in automotives. The coal division’s struggles are still a concern, as the division contributes nearly 30% of our price estimate for the company’s stock, the most among all divisions.

We have revised our forecasts for Norfolk Southern based on the Q2 earnings report and we now have a $78 price estimate for the stock, which is around 10% above the current market price. Key changes include reduced estimates for coal volumes and agricultural and consumer products freight. We increased our near term forecasts for automotive, metal and construction and intermodal freight. We also revised our full year revenue per unit carload figures for all segments based on the earnings release. The other updates include slight increases in near-term margin and cash and debt figures.

See our complete analysis for Norfolk Southern here

Intermodal and automotives freight negating coal volume losses

NSC’s intermodal freight volume growth is in line with the growth in overall intermodal volumes across the U.S., which was nearly 4% y-o-y in Q2. We see intermodal as the primary future growth driver for U.S. railroad companies and market share gains in this segment could render significant revenue growth going forward.

Automotive freight volumes increased by an impressive 16% while revenues in this segment grew by 20% in Q2. We believe automotives growth will continue to fuel the company’s near-term volume growth and help fend off losses in coal freight.

Opportunity in export coal

While the media is abuzz about coal losing its vigor, it was surprising to note that export coal volumes handled by Norfolk’s competitor CSX rose 41% in Q2 and 29% in H1. Norfolk managed only 7% growth in export coal volumes in Q2 but is positioned well to penetrate this market, which has significant potential for future growth. Port terminals are gearing up for tremendous export supplies in the future, which could benefit NSC. We believe that coal freight will rebound to an extent, but it might take some time for it to do so.

Margins continue to rise

Q2 was another successful quarter in terms of margin expansion as all freight categories showed increases in per-unit revenues and declines in expenses. The company’s EBITDA margin was 40.5% in Q2 compared to 37.9% in Q2 2011. Going forward, we expect that fuel costs will decline as oil prices cooled down earlier in the year. This, coupled with positive pricing trends, should drive margin expansion going forward.

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1. Financial Review Q2, nscorp.com, July 24, 2012 [↩]